Foreign and Defense Policy, Europe and Russia

Lies, damn lies, and European credit ratings?

A spate of downgrades of European sovereign debt and European banks has drawn the ire of politicians across the eurozone. For months, leaders have been insisting that the ratings agencies are wrong and worthless, even as sovereign debt continues to balloon and the European Financial Stability Facility looks increasingly inadequate.

Now, as the G20 lectures Europe and debates rage over bailing out European banks, European officials have taken a further step in the direction of dysfunction. A new plan emerged out of Brussels yesterday to take inane steps to “reform” the ratings process, including:

•    Giving power to the European markets regulator (ESMA) to approve ratings methodology and unilaterally ban sovereign ratings under unspecified circumstances.

•    Suspending the rating of sovereign debt for countries receiving bailouts, as those adverse ratings apparently come at “inappropriate moments.”

•    Unifying ratings methodology and issuing ratings standards to which all ratings agencies must adhere.

•    Blocking investors in ratings agencies from investing in multiple agencies simultaneously.

The plan is designed to quell the steady stream of reports that supposedly drive market fear over the state of the eurozone. Politicians have failed to realize that the ratings agencies simply confirm what the markets are already signaling. Silencing the agencies (notably, only within Europe) will do nothing to save the euro, and the markets know it. With interest rates skyrocketing and credit default swap spreads at an all-time high, it is obvious to unbiased observers that we are in the midst of a massive European default. The pathetically inadequate bailout mechanisms are derisory against the gargantuan weight of European debt.

Still more insidious is the assumption that European bureaucrats know better how to evaluate their own liabilities than the ratings agencies owned by shareholders and working on profit motives. Incentives matter, and the current incentive structure works well. If the ratings agencies are wrong—and if they disagree with what the markets say—people won’t value their ratings, and they will not turn a profit. By contrast, Europe’s politicians have a perverse incentive—to cover up the scope of the problem in order to save face and buy time. Evidence for this is the frequently shady figures in Greek government statistics, used to disguise the extent of the crisis.

European leaders should stop fiddling while Rome burns. Instead of pointing the finger at ratings agencies for telling the truth about what markets have been signaling for months, politicians from the Mediterranean to the Baltic should take steps to fix the mess they created.

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